Chapter: Four
Microfinance
Institutions
Introduction of Microfinance Institutions
• Microfinance, also called microcredit, is a type of banking service
provided to low-income individuals or groups who otherwise
wouldn't have access to financial services.
• A microfinance institution is an organization that offers financial
services to low income populations. Almost all give loans to their
members, and many offer insurance, deposit and other services.
• A great scale of organizations is regarded as microfinance institutes.
They are those that offer credits and other financial services to the
representatives of poor strata of population (except for extremely
poor strata).
• While institutions participating in microfinance most often
provide lending microloans. But many banks offer additional
services such as checking and savings accounts as well as micro-
insurance products, and some even offer financial and business
education. The goal of microfinance is to ultimately give
impoverished people an opportunity to become self-sufficient.
• Microfinance is increasingly being considered as one of the
most effective tools of reducing poverty. Microfinance has a
significant role in bridging the gap between the formal financial
institutions and the rural poor.
• The Micro Finance Institutions (MFIs) accesses financial
resources from the Banks and other mainstream Financial
Institutions and provide financial and support services to the
poor.
• Microfinance allows people to take on reasonable small business
loans safely, in a manner that is consistent with ethical lending
practices.
• Like conventional lenders, micro financiers charge interest on loans
and institute specific repayment plans.
• The global microfinance market was valued at an estimated $187
billion in 2022, and is expected to exceed $488 billion by 2030.4
Objectives of Micro Finance Institutions
• A relatively new branch of financial services, microfinance aims to
promote self-sufficiency and economic development among people
who don't have access to the traditional financial sector.
• They do this primarily by extending small loans without the strict
requirements of traditional lenders. Receivers are usually the poor
and "unbanked," but they also include people who are not poor but
who lack the credit standing to borrow money to start or grow a
business.
• Major objectives of microfinance are as follows.
• Access to Capital
• When people can't tap into the mainstream financial services system for
capital to start a business, they're forced to turn to "informal" sources --
relatives, friends and even black-market lenders, or "loan sharks."
• Such sources are often unreliable, and they can also be expensive, charging
potentially ruinous interest rates that can strangle a new business before it
can get established. By lending money to such people, microfinance
institutions provide access to capital.
• Entrepreneurship and Self-Sufficiency
• Underprivileged people may have possibly profitable business ideas, but they
cannot put them into action because they lack sufficient capital for start-up
costs.
• "Microcredit" loans give clients just enough money to get their idea off the
ground so they can begin turning a profit. They can then pay off their micro
loan and continue to gain income from their venture indefinitely.
• Improved Standards of Living
• Microcredit ultimately aims to give poor people enough financial stability to move from
simply surviving to accruing savings.
• This gives them a certain amount of protection from sudden financial problems. Savings also
allow for educational investment, improved nutrition, better living conditions and reduced
illness.
• Micro insurance, another segment of the microfinance sector, provides people the ability to
pay for health care when needed, so they can receive treatment for health conditions before
they become grave and more costly to treat.
• Women's Economic Advancement
• Women make up a large proportion of microfinance beneficiaries. Traditionally, women
(especially those in underdeveloped countries) have been unable to readily participate in
economic activity.
• Microfinance provides women with the financial backing they need to start business
ventures and actively participate in the economy.
• The aim is to improve their status and make them more active in decision-making, thus
encouraging gender equality. According to the international Consultative Group to Assist the
Poor, microfinance institutions have even reported a decline in violence against women in
areas targeted by microfinance programs.
• Trickle-Down Benefits
• Microfinance lenders hope to improve not just the lives of their direct clients,
but also the health of their clients' communities. New business ventures can
provide jobs, thereby increasing income among community members and
improving their overall well-being.
• Other Objectives
• To mobilize and grow deposits.
• Provide excellent and unique services to customers and general public.
• Bring banking services to the door step of the micro saver.
• Innovative products and service excellence in the microfinance sectors.
• Provision of in-house training for staff to acquire and update skills and job
knowledge.
• Grow clean loans portfolio.
• To create opportunities for selfe-eployment for the underprivileged;
Importance of microfinance institutions
• Access to credit can play a pivotal role in economic growth.
Banks and lending institutions provide the services that allow
people to save and invest available assets and resources,
which further supports and strengthens economic activity.
• Within underdeveloped communities, the role of
microfinance institutions provides the credit access and
financial services needed to develop income-earning
businesses. So microfinance institutions paly an important
roles to increase the economic level of marginalized
community as well as economic sector of the nation.
• Major important of microfinance are as follows.
• Access to Financial Services: Within any society, financial services
provide a means for people and businesses to obtain credit and
manage available assets on a continuous basis. Access to financial
services enables existing businesses to grow and provides the starting
capital for starter businesses. Microfinance institutions provide these
services within communities that have limited resources and few
avenues for economic development.
• Use of Microfinance Approaches: On average, loan repayment rates
for microfinace institutions range around 97 to 98 percent, according
to the Developing World Markets news and reference site. This high
repayment rate results from the approach methods used by
microfinance institutions when working within communities.
• Mobilize resources: To mobilize resources in order to provide financial
and support services to the poor, particularly women, for viable
productive income generation enterprises enabling them to reduce
their poverty;
• Reliable Supports: Microfinance institutions provide a reliable source
of financial support and assistance compared to other sources for
financing. Sources operating outside the microfinance industry
typically form informal relationships with borrowers and have no real
legal or substantial ties with their customers.
• It allows people to better provide for their families: Microfinance
allows for an added level of resiliency in the developing world. Even
when households are able to work their way out of poverty, it often
takes just one adverse event to send them right back into it. It’s often
a health care issue that causes a return to poverty.
• It gives people access to credit: Most banks will not extend loans to
someone without credit or collateral because of the risks involved in
doing so, yet those in poverty do not have any credit or collateral.
• It creates the possibility of future investments: Microfinance changes
the condition of poor people by making more money available. When
basic needs are met, families can then invest into better wells, better
sanitation, and afford the time it may take to access the health care they
need.
• create real jobs: Microfinance is also able to let entrepreneurs in
developing countries be able to create new employment opportunities
for others. With more people able to work and earn an income, the rest
of the local economy also benefits because there are more revenues
available to move through local businesses and service providers.
• encourages people to save: Microloans are an important component of
microfinance, but so is saving money. When people have their basic
needs met, the natural inclination is for them to save the leftover
earnings for a future emergency. This creates the potential for more
investments and ultimately even more income for those who are in the
developing world.
• It serves those who are often overlooked in society. About 95 percent of
some loan products extended by microfinance institutions are given to
women, as well as those with disabilities, those who are unemployed,
and even those who simply beg to meet their basic needs, Vitanna notes.
Microfinance services can help recipients take control of their own lives.
• It offers significant economic gains even if income levels remain the
same. The gains from participation in a microfinance program including
access to better nutrition, higher levels of consumption, and eventually,
growing economies, even in small and impoverished communities.
• It leads to better loan repayment rates. "Microfinance tends to target
women borrowers, who are statistically less likely to default on their loans
than men. So these loans help empower women, and they are often safer
investments for those loaning the funds," says Plan International.
• It extends education. Families receiving microfinance services are less
likely to pull their children out of school for economic reasons, says Plan
International.
Attributes of a good microfinance institutions
1. Good governance.
2. Sufficient resource.
3. Varity of service.
4. Transparent.
5. Protection risk of poor people
6. Number of branch and service agent
7. Number of customers
8. Loan providing without collateral
9. Quick service.
10. Door to door service
Types of
Microfinance
institutions
semiformal informal
formal financial
financial financial
institutions
institutions providers
Types of microfinance institutions
• Microfinance organization or institutions is not new to the financial market in
Nepal.
• Due to the overwhelming poverty in Nepal, government gave special
attention to the development of rural credit.
• Taking All Nepal Rural Credit Survey, it reconstructed the cooperative
structure which included the partnership of state in cooperatives,
establishment of Regional Rural Banks (RRB) and National Bank for
Agriculture Development (ADB). In Nepal.
• Non Government Organizations (NGOs) played a pivotal role in the
development of micro financial service. Furthermore, microfinance industry
in Nepal has observed a fast-paced growth in last two decades.
• In the context of lending in developing countries, formal, informal and
semiformal financial sectors coexist, even in situations where interest rates in
the three sectors differ greatly.
formal financial institutions
• A financial institution is an establishment that conducts financial
transactions such as investments, loans and deposits. Almost everyone
deals with financial institutions on a regular basis. Everything from
depositing money to taking out loans and exchanging currencies must
be done through financial institutions.
• The formal sector is primarily constituted by formal financial
institutions including private and state commercial banks.
• The theoretical literature on credit markets in developing countries
emphasizes that there are huge differences, in terms of lending
practices, between formal, informal and semiformal financial
institutions
• Formal financial institutions ignore small savings and credit facilities for
small farmers, lower-income households, in rural areas.
Formal Financial
Institutions
Commercial
Bank
Dev. Bank and All types of
Insurance
finance Investment
Company
company company
Feature of formal financial institutions
• Legally registered.
• Large capital
• Number of investors
• Follow the rules and regulation of government
• Use modern tools and technology to keep overall record of business
transaction
• Run by staffs
• Need of collateral
• High interest rate than microfinance
Semi-formal financial institutions
• Semi-formal Financial Institutions (SFIs) have increasingly become
involved in the financing of micro and small enterprises (MSEs).
• SFIs are unregulated but legal financial entities operating in the semi-
formal financial sect or which can be divided into membership-based
Self-Help Organizations (SHOs) and outside assistance-based Non-
Governmental Organizations (NGOs).
• SHOs are indigenous private institutions which finance activities in
poor communities with funds mobilized in the community itself.
• The sources of semiformal credit are various national and
international credit programmes in charge of providing microfinance
to a selective range of borrowers and conforming to certain
development targets.
• Examples of membership-based SHOs are local community banks,
credit unions, and loan and savings cooperatives and associations.
• Generally, SHOs are fully engaged in financial intermediation by raising
member deposits and transforming them into member loans. NGOs,
however, often only distribute and collect loans, resulting in an
intermediation function which is much more limited. Usually, NGOs
generate their funds from outside donors or governments, making
themselves more dependent from outside priorities and availability of
funds.
• Credit delivery is one of the means to contribute To the development of
the MSE sector and improve the living and working conditions of the
poor.
• Practice has shown that financial institutions that perform well generally
mobilize a relatively large proportion of their credit funds through
deposits.
• Unfortunately, the provision of savings services is traditionally either
omitted, included primarily as an educational device, or added as an
afterthought.
• In this way, the real need of poor people for a safe, convenient savings
institution is not addressed.
• It is emphasized, that individuals benefit much more from having save
and convenient places to hold their savings with ready access to
money, and having dependable working relationships with financial
institutions which offer both lending and deposit facilities designed
with client needs and preferences in mind, than they do from getting
single loans. For this reason, the monitoring system is addressing
credit as well as savings issues.
• In practice, SFIs play an important role in the promotion of small
enterprise development because they tend to have a better grasp of
the local demand of small entrepreneurs than formal financial
institutions.
• SFIs appear to have better knowledge about the micro and small
entrepreneurs than banks.
Semi-formal
financial
institutions
loan and savings
membership- local community
credit unions cooperatives and
based SHOs banks
associations.
Feature of Semi formal financial institutions
• Legally registered but get approval form regulatory bodies to run
financial activities.
• Limited capital
• Minimum member
• Follow the rules and regulation of government
• Use of manual record system
• Run by voluntarily
• Grand and donation are the major source of capital for semi formal
financial institutions .
• Group agreement accept as a collateral
• Group basis
Informal Financial providers
• ‘while the formal sector appears to have a comparative advantage over the
informal sector in intermediating funds over space and reaping scale economics, it
seems to fare worse in enforcement and information problems.
• Informal lenders, such as moneylenders, often maintain close contacts with their
clients. This enables them to finance, without serious risks, those who otherwise
would not obtain a loan at all. Moreover, it is argued that informal loans involve
much less collateral than similar commercial bank loans. For this reason, informal
lenders often search for collateral substitutes in order to lower the risk of their
loan portfolio.
• Therefore, it seems intuitive that screening and monitoring of borrowers and
adequate enforcement mechanisms differ between types of lenders.
• Yet, it is hard to find empirical evidence that supports this proposition. While the
theoretical literature on irregular information and its consequences for the lending
practices of financial intermediaries abounds, hardly any empirical work has been
done to attempt to characterize lending policies of different types of financial
intermediaries. It is surprising that it is rare to find any empirical evidence on the
effect of imperfect information on the behaviour of credit market Lending Policies
of Informal, Formal and Semiformal Lenders
• However, the economic benefits of IFIs are also important – not least from
a national perspective. IFIs give poor people an opportunity to start
investing in education, a small business, etc.
• In rural areas, not belonging to an IFI group can be seen as selfish and as
demonstrating an unwillingness to contribute to the community’s
development. Therefore most people join one or more groups, even if
they earn a good salary and do not have an economic need to participate.
“Especially in rural areas, joining an IFI group is more important socially
and culturally than economically.”
• The process of taking on new members in an informal financial institution
(IFI) group relies on personal relationships, whereby one or more
members can recommend a new person who wants to join.
• Different informal found follow the some rules, when they taking on new
members, issues of sex, age, occupation and marital status were more
important than ethnicity
Feature of informal financial providers
• No rules
• Personal relationship.
• Interest rate is higher than financial institutions.
• No need of collateral.
• Short term period.
• Immediate landing
• No any record system